Central banks seek out riskier assets for reserves in yield drought

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Central bankers who manage foreign currency reserves have been turning to new — and riskier — investments to compensate for the global collapse in bond yields ushered in by the pandemic, according to a new survey.

The annual poll of 78 reserve managers with a combined $6.4tn of assets found that the reduction in yields has presented the greatest challenge to these investors over the past year. For many, it has driven a shift into new asset classes including corporate bonds, emerging market bonds and equities.

Reserve managers are typically among the world’s most risk-averse investors, but they enjoy huge clout thanks to the more than $12tn they manage, according to the most recent IMF figures. This cash, accumulated by central banks to keep their currencies steady or to protect them in times of crisis, is generally parked in safe assets such as short-term government debt.

However, the survey carried out by Central Banking Publications suggests the pressure of low returns is forcing some to take on greater risk to preserve their capital. Bond yields around the world plummeted to record lows last year as central banks slashed interest rates and launched huge debt-buying programmes to combat the fallout from the pandemic. Although yields have since rebounded, they remain very low by historical standards.

Just over half of respondents to the survey said they were considering investing in new asset classes, while 44 per cent said they might add new currencies to their holdings. According to the IMF, 59 per cent of the world’s $12.7tn of foreign exchange reserves is held in US dollars, with most of the rest in euros, yen or sterling.

The survey also found that 42 per cent were considering inflation-linked bonds and 23 per cent were looking at adding to their holdings of gold.

Another reserve manager from the Americas said they had increased holdings of Chinese bonds, inflation-linked bonds and gold, adding “we are always willing to look into opportunities to make our reserves more efficient in terms of risk/ return”.

Central banks, like many investors, have been struggling with falling bond yields for the past decade, resulting in a global “hunt for yield” that has buoyed riskier assets. Many of the safest bonds offer negative returns once inflation is taken into account, while in Japan and the eurozone negative nominal yields are also commonplace.

The survey highlights “the challenge of capital preservation faced by the large number of reserve managers who hold predominantly short duration portfolios in highly rated government securities”, said Bernard Altschuler, head of central bank coverage at HSBC.